Why the First Five Years of Retirement Matter More Than the Rest: Understanding Sequence of Returns Risk

If you are within a few years of retiring, or you just retired, you have probably heard that markets go up and down over time and that, historically, they tend to recover. That is true over long stretches of saving. But once you start drawing income from your portfolio instead of adding to it, the order in which good and bad years happen can matter almost as much as how the market performs on average.

This is called sequence of returns risk. It is not about whether markets will eventually recover. It is about what happens to your account, and your future income, if a downturn hits in the first few years you are relying on that money.

The good news is that this risk is well understood, and there are practical ways to plan around it. Let's walk through what it is, why timing matters so much, and what retirees and advisors typically do about it.

Key takeaways

• The average return your portfolio earns over retirement matters less than the order in which returns happen, especially in the first five to ten years.
• Withdrawing income during a market downturn locks in losses in a way that simply riding out a downturn while still working does not.
• Two retirees with identical average returns can end up with very different outcomes depending on whether the down years came early or late.
• Cash reserves, flexible withdrawal approaches, and diversified income sources are the main tools used to manage this risk.
• A periodic plan review helps catch early warning signs and adjust before small problems become big ones.

What is sequence of returns risk?

While you are working and adding to your retirement accounts, a down market year is generally a buying opportunity. You keep contributing, prices are lower, and time is on your side.

Retirement flips that dynamic. Once you begin taking withdrawals, you are selling investments to generate income, often on a set schedule. If the market is down when you sell, you lock in that loss and you have less money left to benefit when the market eventually recovers. A downturn that happens early, while your account is at its largest and you have the most years of withdrawals ahead of you, can do more lasting damage than the same downturn occurring later, after your portfolio has had years to grow.

A simple, hypothetical example

Here is an illustration to show how this works. The numbers below are entirely hypothetical, not based on actual market data or any real client outcome, and are meant only to demonstrate the concept.

Imagine two retirees, each starting retirement with a $1,000,000 portfolio and withdrawing $50,000 per year, adjusted for the portfolio's performance. Each portfolio experiences the same five annual returns over the same five years, just in a different order.

Retiree A experiences returns in this order: -20%, -10%, +5%, +15%, +20%. Retiree B experiences the exact same returns in reverse: +20%, +15%, +5%, -10%, -20%.

Both retirees earn the same average return over the five years. But Retiree A, who faced the losses first while also withdrawing income, ends the period with meaningfully less money than Retiree B, who faced the losses last after the portfolio had already grown. The math is the same in both directions on paper. In practice, withdrawing income during the down years is what makes the difference.

This is the essence of sequence of returns risk: identical long-term average returns can produce very different results depending on when the good and bad years happen to fall.

Why this matters more early in retirement

The first five to ten years after you retire are often called the "fragile decade" for this reason. Your portfolio is typically at its largest size, you have the most years of withdrawals still ahead, and there is less time to recover from an early setback before you need to rely on that same money again. A downturn ten or fifteen years into retirement, after your portfolio has had time to grow and you have fewer years of withdrawals left, generally has less impact.

Practical ways retirees manage this risk

Cash reserves and bucket strategies

Some retirees and their advisors set aside one to three years of anticipated spending in cash or short-term, lower-volatility investments. The idea is to draw income from that reserve during a market downturn instead of selling stocks at a loss, giving the rest of the portfolio time to recover before it is tapped again.

Flexible or guardrail-based withdrawal rates

Rather than committing to a fixed withdrawal amount every year regardless of market conditions, some retirees use a flexible approach: trimming spending slightly in years the market is down and allowing more room in strong years. This kind of guardrail approach is designed to reduce the amount withdrawn during downturns without requiring dramatic lifestyle changes.

Diversified income sources

Relying on more than one source of retirement income, such as Social Security, a pension, part-time work, or an annuity alongside investment withdrawals, can reduce how much you need to pull from your portfolio during a rough market stretch.

Regular plan reviews

A retirement income plan is not a one-time decision. Reviewing it periodically with an advisor, and adjusting course early if markets move against you, tends to work better than waiting until a problem is already significant.

Common mistakes to avoid

• Assuming that because average long-term returns are positive, the order of returns does not matter.
• Keeping no cash reserve and being forced to sell investments at a loss to cover everyday expenses.
• Sticking rigidly to a fixed withdrawal amount regardless of how markets are performing.
• Waiting until a downturn is already underway to think about a withdrawal strategy for the first time.

When to talk with us

Every household's situation is different, and there is no single right answer for how much cash to hold, how flexible a withdrawal rate should be, or how to sequence income sources. If you are within a few years of retiring or have recently retired and want to understand how this risk might apply to your own plan, we welcome a conversation. You can reach out to us or learn more about our approach to retirement planning.

Frequently asked questions

Is sequence of returns risk the same as market volatility? Not exactly. Volatility describes how much returns move up and down. Sequence of returns risk describes how the order of those ups and downs, combined with the fact that you are withdrawing money, affects your outcome.

Does this only affect people who retire during a bad market? It is most relevant to anyone retiring or already retired, since no one can predict in advance what the market will do in their first few retirement years. Planning ahead of time is what allows you to respond calmly if a downturn does occur early.

If I already retired during a strong market, am I in the clear? A strong start is helpful, but the fragile decade generally spans the first five to ten years of retirement, so it is still worth having a strategy in place.

How much cash should I keep on hand? There is no universal number. Some retirees keep one year of expenses, others keep more. The right amount depends on your spending needs, other income sources, and comfort with market swings.

Will a bucket strategy guarantee I avoid losses? No strategy can guarantee against losses or eliminate risk. A bucket or cash reserve approach is designed to reduce the need to sell investments during a downturn, not to prevent downturns from happening.

What is a guardrail withdrawal strategy? It is an approach where your withdrawal amount can flex up in strong years and down in weak years, rather than staying fixed regardless of market conditions.

Should I delay retirement if the market looks shaky? That is a personal decision that depends on your full financial picture, health, and goals. It is worth discussing with an advisor rather than deciding based on short-term market headlines alone.

Does diversifying income sources really reduce this risk? Having income from sources like Social Security, a pension, or part-time work alongside portfolio withdrawals can reduce how much you need to withdraw from investments during a downturn, which can soften the impact.

How often should I review my retirement income plan? Many households benefit from at least an annual review, with additional check-ins after a significant market move or major life change.

Is this something I can manage on my own, or do I need an advisor? Some people manage it independently, but because it involves tradeoffs across spending, taxes, and investment choices, many retirees find it helpful to work through the details with a fiduciary advisor.

Sources

• CFP Board, Find a CFP® Professional directory (certification verification)